Keeping DC members saving until retirement

Amidst the brouhaha over the liberalisation of retirement options ushered in by the Chancellor, George Osborne, it is easy to forget the long journey that defined contribution (DC) members need to travel to take advantage of them.

26/09/2014

Amidst the brouhaha over the liberalisation of retirement options ushered in by the Chancellor, George Osborne, it is easy to forget the long journey that defined contribution (DC) members need to travel to take advantage of them. However attractive the Chancellor makes the ultimate destination, it can still seem like a long – and rocky – road for a worker with 20 or more years of saving ahead of them.

One of the key challenges faced by trustees and employers is to keep their members focused on the prize. Saving for a pension can feel like a low priority compared with more immediately pressing needs for their cash, such as the mortgage, the next holiday or a new car.

We believe the answer is to treat pension saving as a journey. The scheme, or more particularly its default approach (or approaches), should be carefully designed to make the journey as painless as possible. This, we think, depends on trustees, employers and investment providers working together to build a DC lifestyle approach that maximises the growth of the member’s savings, while minimising unpleasant shocks. Achieving that happy equilibrium means setting the right balance between risk and return all the way along the route.

Of course, the balance changes as the member gets older. We would argue that a young worker starting out on their career can – and indeed should – take investment risks in order to build their small savings quickly. If they then hit a bad patch in the market they have plenty of time to rebuild their savings with regular contributions and investment growth.

But as they get into their 40s and 50s, the balance shifts. They have less time left before work income stops, so it is harder for them to recover from losses. They can therefore afford to take fewer risks. At the same time, any growth they can achieve should have a much greater compounding effect on what should be a much bigger savings ‘pot’. Indeed, middle age is arguably the best opportunity they have to use so-called ‘money-weighted’ returns to build their capital. Unfortunately, unless carefully managed, these objectives can conflict with each other. Furthermore, any well-designed default also needs to take account of the behavioural issues that members face.

Psychologically, it can be hard to invest in growth assets like shares when markets dive. Few people find it easy to keep paying into an investment that appears to have swallowed a significant slice of their hard-won savings. It can feel like sending good money after bad. So it’s really important that these bumps are smoothed out as much as possible to make the member’s savings journey as comfortable as possible. Doing so should give them the confidence to maintain and, ideally, increase their contributions.

Unfortunately, as the chart shows, these risks are not often adequately dealt with by traditional lifestyle approaches that don’t start de-risking the saver’s portfolio until they reach at least 55 (and sometimes later). A big loss incurred at this stage may be irretrievable, given the limited time such a member has left for saving, leaving them with less money than they expected in retirement. And if it unsettles them sufficiently to prompt them to move into more risk-averse (and therefore lower growth) investments or, worse, reduce their contributions or stop saving altogether, the result could be disastrous for their ultimate pension pot.

A better approach, we believe, is to balance risks by investing in a broad range of asset classes, while aiming to achieve a lower level of volatility than equities and seeking to minimise big losses. Any performance target should be set at a substantial margin over inflation to build the member’s fund in real terms. We believe a stable growth fund is ideal for these purposes.

Schroders was one of the pioneers of this approach in the DC market. Launched three years ago, the Schroder Life Diversified Multi-Asset Fund (DMAF) seeks growth with lower risk by using dynamic techniques to invest in multiple assets. It now has a proven track record that has comfortably beaten inflation since inception. And the good news for trustees struggling with the government’s new charge cap is that it costs only around two-thirds the level set by the new limit, with ongoing charges capped at 0.5%.

Unlike rivals, the fund actively allocates members’ assets between passive and active managers, both internal and external. In doing so, it aims to beat the consumer price index by at least 4% after fees over a rolling five-year period. At the same time, it manages risks for the member with a target to limit volatility to a maximum of 10%.

We think a stable growth fund like DMAF has lots to offer pension members in the middle to later stages of their savings journey. In doing so, it should also be of enormous benefit to trustees and employers seeking ways of improving member outcomes, while keeping within the new charge cap.

Important information: The views and opinions contained in the article are those of Hilary Vince, DC Strategy Manager at Schroders, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.

This material is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Pension Management Limited does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Funds which invest in a smaller number of stocks can carry more risk than funds spread across a larger number of companies. The Schroder Life Dynamic Multi-Asset Fund invests in a fund that is authorised as a non-UCITS retail scheme. The investment and borrowing powers of these types of scheme are wider than those for UCITS funds whilst still aiming to provide a prudent spread of risk. The fund invests in assets which are exposed to currencies other than sterling. Exchange rates may cause the value of overseas investments and the revenue from them to rise or fall. The fund is not tied to replicating a benchmark and holdings can therefore vary from those in the index quoted. For this reason the comparison index should be used for reference only. The fund uses derivatives for investment purposes. This involves a higher degree of risk and may lead to a higher volatility in the unit prices of the fund. The Manager employs a risk management process to allow the Manager to measure derivative and forward positions and their contribution to the overall risk profile of the Schroder Life Dynamic Multi-Asset Fund. As part of this risk management process, the manager conducts daily Value at Risk analysis of the fund and performs both stress and back testing of the fund. The fund invests in unregulated collective investment schemes, which involves a higher degree of risk as they are not regulated by the FCA. The funds may not be readily realisable and priced less frequently than listed shares or authorised unit trusts, and therefore price swings may be more volatile. Unregulated schemes may be closed for subscription and/or redemption may be subject to certain restrictions or limitations and there is unlikely to be an active secondary market in the shares or units of such underlying schemes. Some schemes may only be available for subscription or redemption on a periodic basis. The fund invests in alternative investments (including commodities) which involves a higher degree of risk and can be more volatile. They should only be considered as a long term investment. The forecasts included in this brochure should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors. Issued by Schroder Pension Management Limited. Registered in England and Wales 5606609. Registered office: 31 Gresham Street, London EC2V 7QA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be recorded or monitored. INS03244 w45757

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